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Earnings Fail to Impress the Market

The emerging market turmoil is dominating the headlines, but we are entering the heart of 2013 Q4 earnings season this week, with as many reports coming out this week alone as have come out the entire season thus far. In total, we have more than 440 companies reporting results this week, including 123 S&P 500 members.

We will see results this week from a diverse group of bellwethers from Tech leaders like Google (GOOG), Apple (AAPL) and Facebook (FB) to Basic Materials players like DuPont (DD) and Dow Chemicals (DOW) and Energy leaders like Exxon (XOM - Free Report) and Chevron (CVX). By the end of this week, we will have seen results from almost half of the S&P 500 members.

We have a good sense of the Q4 earnings season already, having seen results from 122 S&P 500 companies or 24.4% of the index’s total membership that combined account for 33% of its total market capitalization. The emerging narrative in the market appears to be of surprisingly mixed or unimpressive results.

But the fact is that in many respects the Q4 earnings season is no different from what we saw in Q3 and other recent quarters. What may be different, however, is that folks have finally started paying closer attention to corporate earnings. And while earnings aren’t bad, they are not consistent with a stock market that, till a few days back, was sitting pretty in record territory either.

It appears that the market was looking for something better, particularly on the guidance front. The hope was, and still is, that given the improving domestic economic scene and signs of stabilization in Europe, we will get relatively reassuring guidance from management teams. But we are not seeing that, with managements continuing to provide sub-par outlook for the coming quarter(s). In other words, management teams are dishing out what they have been doing for more than a year now. And this is prompting estimates for the current quarter to come down, as the chart below shows.

Q3 Earnings Scorecard (as of Friday, 1/24/2013)

Total earnings for the 122 S&P 500 members that have reported already are up + 18.8% from the same period last year, with a ‘beat ratio’ of 66.4% and a median surprise of +2.0%. Total revenues are up +3.8%, with a revenue ‘beat ratio’ of 58.2% and a median surprise of +0.9%.

But the beat ratios started out on the weak side, but have caught on with recent historical levels, as the chart below shows.

The growth rates for these 122 companies are better than what we saw from this same group of companies in Q3 and the 4-quarer average, as the chart below shows.

But a big contributor to the strong Q4 growth is easy comparisons for just three companies – Bank of America (BAC), Verizon (VZ - Free Report) , and Travelers (TRV - Free Report) . Exclude these three companies and total earnings growth for the S&P 500 companies that have reported drops to +7.1% from the ‘headline’ +18.8%, which is about where growth has been in recent quarters.

The Composite Growth Picture

The ‘composite’ picture for Q4, where we combine the results from the 122 companies that have reported already with the 378 still to come, is for growth rate of +8.4%. This reflects +1.8% higher revenues and net margin gains of about 59 basis points. Finance remains a big growth driver in Q4 – total earnings growth for the S&P 500 in Q4 drop to +4.8% once the sector is excluded.

Technology earnings are expected be up +4.5% after the +5.9% gain in Q3. We will get results from Apple, Google, Facebook, Yahoo and others this week, but total earnings for the 37.1% of the sector’s market cap that have reported already are up +10.4% from the same period last year.

Microsoft did quite good in its quarterly release, despite its oversized exposure to tight spending by businesses. Sales at the company’s commercial business unit, which houses its server and office offerings and brings in about two-thirds of its total earnings, jumped 9.9%, bucking the trend we saw at IBM (IBM) and other old-line Technology firms. The company’s consumer offerings also appear to have hit a stride, with strong momentum in the Xbox and Surface products. The stock responded strongly to the earnings release, but the market is patiently waiting for the announcement of a new leader at the company who will replace Steve Ballmer and give it a new strategic push. The board is apparently looking for an outsider, which is a sound strategy given the company’s need for a fresh look at its disparate assets.

Lack of corporate capital spending has been an issue for the sector for some time and the consensus view is that we will see a turnaround on that front later this year. We haven’t heard anything yet that will add to our confidence in that expectation. But this optimistic view is a big contributor to the expected upturn in the Tech sector’s growth estimate later this year. Total earnings for the sector are expected to be up +9.8% this year and +10.8% in 2015, pronounced acceleration from the flat reading in 2013.

Will Guidance Finally Turn Around?

For obvious reasons, the market is very interested management guidance for 2014. Companies typically provide guidance only for the following quarter, but they do tend to discuss their outlook their outlook for the coming year on the Q4 earnings calls. It will be interesting to see if management teams see any material improvement in the earnings picture this year along the lines of current consensus earnings expectations for 2014.

Total earnings are expected to be up +9.1% in 2014, up from +2.0% growth in 2013, with most of the growth coming in the back half of the year.

Monday-1/27

We will get the December New Home sales numbers in the morning, with expectations of a flat reading from November’s 464K level.

Apple (AAPL) is the key earnings report after the close, while Caterpillar (CAT) will report in the morning.

Tuesday -1/28

We will get the December Durable Goods orders report in the morning, with expectations of a ‘headline’ gain of +1.8% after the +3.8% gain the month before. We will also get the Conference Board’s January Consumer Confidence report, with expectations of a modest increase from the prior 78.1 reading.

Stocks with positive Earnings ESP and Zacks Rank of 1, 2 or 3 are highly likely to come out with positive earnings surprises. Pfizer has a Zacks Rank #3 (Hold) and Earnings ESP of +1.9%, while AT&T has a Zacks Rank # 3 (Hold) and Earnings ESP of +2%.

To get a better understanding of Zacks Earnings Surprise Predictor, please click here.

Wednesday-1/29

We will get the FOMC meeting announcement in the afternoon, with no major changes expected to the Fed’s Taper plans, notwithstanding the emerging markets turmoil it has caused. The emerging markets troubles have helped spotlight the U.S. Treasury bonds’ safe-haven status and brought yields down. The Fed may not acknowledge it, but they don’t mind the lower treasury bond yields.

Boeing (BA) and Dow Chemicals (DOW) are the key reports in the morning, while Facebook (FB) and Qualcomm (QCOM) will report after the close.

Earnings ESP is showing Facebook coming out with a positive earnings surprise. Facebook has Zacks Rank #3 (Hold) and Earnings ESP of +4.8%.

Thursday -1/30

In addition to weekly Jobless Claims, we will get the first read on Q4 GDP, which is expected to come in at +3.2% after the revised +4.1% growth in Q3. GDP growth estimates for Q4 increased materially as the quarter unfolded from close to +1% at the start of the quarter to the current +3.2%.

We will get the December Personal Income & Outlays report in the morning, while the final University of Michigan Consumer Sentiment survey for January will come out after the markets open. Unlike the Conference Board’s survey, the Michigan survey is expected to be essentially flat from the prior 80.4 reading.

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